Venture Capital Companies

What are Venture Capital Companies?

One of the main challenges to the growth of small and medium-sized businesses and junior mining exploration is access to equity finance. To assist these sectors in terms of equity finance, Government has implemented a tax incentive for investors in these enterprises through a venture capital company (VCC) regime.

VCCs are intended to be a marketing vehicle that will attract retail investors. An investor is any taxpayer who qualifies to invest in an approved VCC. They have the benefit of bringing together small investors as well as concentrating investment expertise in favour of the small business sector. There are no special tax benefits for the VCC itself, only standard tax rules will apply.

Who are they for?

From 1 January 2009, investors can claim amounts incurred on acquiring VCC shares as a deduction from income. However, from 21 July 2019, investments made by a natural person and trusts will be capped at R2.5 million and for companies, investments will be capped at R5 million. This cap is per tax year. This deduction will not be subject to recoupment if the VCC shares are held for longer than five years.

A company must meet all of the following preliminary requirements to be able to obtain a SARS approved VCC status:

The company must be a resident;
The sole object of the company must be the management of investments in qualifying companies (i.e. investees);
The company’s tax affairs must be in order; and
The company must be licensed in terms of section 8(5) of the Financial Advisory and Intermediary Services Act, 2002.

Who qualifies to be a Section 12J Investee?

The Investee must be a company;
The company must be a resident;
The company must not be a controlled group company in relation to a group of companies;
The company’s tax affairs must be in order (a tax clearance certificate must be requested from SARS to support this requirement);
The company must be an unlisted company (section 40 of the Act) or a junior mining company; A junior mining company may be listed on the Alternative Exchange Division (AltX) of the JSE Limited;

During any year of assessment, the sum of the “Investment Income” derived by the company must not exceed 20% of its gross income for that year of assessment.

The company must not carry on any of the following impermissible trades:

• Any trade carried on in respect of immoveable property, except trade as a hotel keeper (includes bed and breakfast establishments);
• Financial service activities such as banking, insurance, money-lending and hire purchase financing;
• Provision of financial or advisory services, including legal, tax advisory, stock broking, management consulting, auditing, or accounting;
• Operating casino’s or other gambling related activities including any other games of chance;
• Manufacturing, buying or selling liquor, tobacco products or arms or ammunition; or
• Any trade carried on mainly outside the Republic.

Section 12J represents an important step towards stimulating the supply of private sector venture funding by incentivising investors through tax deductions.

To assist these sectors in terms of equity finance, government has implemented a tax incentive for investors in such enterprises through a Venture Capital Company (VCC) regime.

Investors can claim income tax deductions in respect of the expenditure incurred in exchange for VCC shares. The VCC is intended to encourage an investment in the local small business sector.

Section 12J is subject to the provisions of the Income Tax Act No. 58 of 1962 (the Act). Section 12J was introduced to cater for the deductions in respect of expenditure incurred in exchange for the issue of venture capital company shares.

The tax benefit which arises from Section 12J is thus an incentive for taxpayers to invest indirectly in SMEs.

Who are allowed to invest in a Section 12J Company? 
Any taxpayer qualifies to invest in an approved VCC.

Are there any other tax implications?
As with any other investment on realisation the taxpayer will be liable for capital gains tax (CGT). However, if the investor utilised the Section 12J deduction when they purchased the shares, the base cost will be reduced to zero on realisation. Therefore, the capital gains tax liability is higher than it would have been for the same investment where the Section 12J deduction was not applied.

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